A "shareholder trust" is a trust which holds shares in a corporation. For purposes of this discussion, it also could relate to a trust holding an interest in a limited liability company or partnership.
In recent years, estate planning has resulted in the use of trusts holding interests in family businesses, as trusts are intended to be multigenerational in duration. This significant use of long-term shareholder trusts to hold interests in family-held enterprises raises some interesting questions about the relationship of the individual family member beneficiaries to the entity.
In particular, do any duties exist that run from the entity or those in control of the entity directly to the beneficiaries? This is an important question, given the use of long-term trusts holding interests in family-controlled businesses.
Under traditional legal doctrine, only the trustee of a shareholder trust is in title and therefore considered the shareholder, member or partner. Any action regarding the interest can only be asserted by the trustee as the owner. Any fiduciary duties that might otherwise exist between those in control of the entity and other interest holders such as the shareholder trust may run only to the trust. The traditional approach is that duties would not run around the trustee directly to the beneficiaries.
When the trustee also has a role in the entity in which the trust has an interest, issues relate to the intersection of the fiduciary duties in respect of the entity (owed to all holders of interests) and those related to the role as trustee in respect of the interest held for the benefit of the beneficiaries. This has been described as an intersection matter and has been discussed in previous blog posts. (See " Multiparticipant Trusts and Conflicting Duties," April 13, 2016, and " Trustees Holding Interests in the Family Business: Intersection of Shareholder and Member Rights and Fiduciary Duties," Sept. 4, 2013.)
The traditional legal approach may not be effective or appropriate in addressing the issue of the expectations of beneficiaries relative to involvement in the business held by the shareholder trust.
We have had matters in which a family member-beneficiary of a shareholder trust was fired in a manner that would have been considered shareholder oppression if directly a shareholder. In several instances, the beneficiary had believed that the position as a family member-beneficiary was the same as direct involvement. Under the traditional model, the beneficiary probably would lack standing to bring a direct action against those in control of the entity. Standing would be considered as existing only with the trustee. If the trustee does not take action, then the beneficiary would lack any recourse other than against the trustee. However, the loss of employment, etc. might not be a benefit that the trustee had a duty to protect.
Breaches of duty at the entity level, i.e., breach of duties of loyalty, care or bad faith, would ordinarily be asserted directly by the trustee as the shareholder, member or partner. When injury to the interest held in trust is alleged and the trustee refuses to take action, case law in a number of jurisdictions recognizes the ability of a beneficiary to bring an action in the name of the trust to protect the assets or seek a damage recovery. The beneficiary would act derivatively in the name of the trust.
At the same time, the failure of the trustee to take action could be a breach of the duty of care or even loyalty.
A loss of benefit to the beneficiary in the form of loss of employment or other actions that might be potentially oppressive might not be considered an injury to the trust nor allow for the beneficiary to directly assert the oppressive action in the beneficiary's own name.
What if the expectations of beneficiary family members included the prospect of direct involvement in the enterprise; would that expectation be considered a benefit of the trust? Would it allow for a direct action if the result of oppressive actions, or would it have to be asserted by the trustee as some form of benefit arising in connection with the equity?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.